The Federal Reserve, as expected, slashed a key interest rate, but whether that cut will be passed along to individual cardholders depends on the bank, the card agreement and the credit standing of the consumer.
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Committee members voted 8-2 on Tuesday to lower the federal funds rate from 3 percent to 2.25 percent. It was the sixth consecutive rate cut; in September, the fed funds rate stood at 5.25 percent. “Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters,” the Fed said in the statement accompanying the rate-cut announcement.
The series of cuts “should help to promote moderate growth over time” the statement said. Noting that it will act in a “timely manner as needed,” the Fed left the door open to further rate cuts. The dissenters in the vote were Dallas Federal Reserve President Richard W. Fisher and Philadelphia Federal Reserve President Charles I. Plosser, “who preferred less aggressive action at this meeting.”
The latest cut puts additional downward pressure on consumers’ monthly credit card bills. Most consumers with variable-rate credit cards — and that’s most cardholders — have their rates indexed to the prime rate. Because banks always peg their prime rates to the federal funds rate, the prime rate will also fall 0.75 percentage point, to 5.25 percent.
Issuers pass along rate cuts unevenly
Since a majority of card-issuing banks base their annual percentage rates (APRs) on the prime rate, credit card rates may also fall. But credit card issuers also may change their policies at any time with 15 days’ notice to consumers, so they can decide to keep the rate cut in their pockets rather than pass it along.
Amid losses from the subprime mortgage industry’s collapse, issuers have been more generous with certain types of cardholders than others. According to the CreditCards.com weekly survey of credit card rates, large rate declines of at least 2 percent have taken place in the business, instant approval, balance transfer and airline credit card categories since September. Others have seen less rate movement — the bad credit card segment, which is comprised mostly of fixed-rate cards, has seen virtually no movement in its rates in six months.
Who benefits from rate cuts?
Not all credit cardholders stand to benefit from Fed rate decisions. Whether your credit card rate falls, and how soon, is determined by several factors.
Key among them:
• Whether the card carries a fixed rate or a variable rate.
• The timing of the change, as dictated by the card agreement.
• The decision of card issuers, which can change any term of the agreement, including interest rate, with just 15 days’ notice.
• Whether the card carries a variable rate or a fixed rate. Cardholders will need to read their card agreements to see whether they signed up for a fixed- or variable-rate credit card. Fixed-rate cards, as the name implies, are not pegged to the prime rate. They are set at the number spelled out in the agreement — but again, the issuer can change that agreement in just 15 days.
Experts agree that consumers need to check their cardholder agreements to find out what a rate cut means for them. “It depends on what the terms of the contract are,” says Dennis Moroney, senior bank card analyst with TowerGroup. “On fixed rate cards, it becomes more of a challenge.”
Will rate cut be passed along?
Moroney believes that banks will speedily pass along rate relief to consumers following the Fed announcement. “That should translate into opportunities for lower interest rates on all consumer products,” Moroney says. “In this type of rate environment, most banks want to act quickly.”
But some experts predict tougher terms for certain classes of cardholders. Such a substantial rate cut “may send a note of panic to the credit markets,” says Lewis Mandell, professor of finance and managerial economics at the University at Buffalo, SUNY. “This could well have the effect of causing an increase in finance charges for credit card users rather than a decrease, reflecting a fall in the cost of funds if lenders perceive that the Fed’s announcement conveys a significant increase in the risk premium,” Mandell says. “The greatest increase will tend to fall on the least creditworthy, probably exacerbating the rate spread between prime borrowers and others.”
Moroney disagrees. “Banks are more focused on risk and delinquency so their priority would be giving the consumer some relief,” he says. “What would trigger punitive pricing would be action on the side of the consumer,” not simply banks’ reaction to the Fed decision.
How soon will card rates change?
The card agreement also spells out how soon an issuer will change its variable rates once prime rate moves. Some can pull the trigger at the end of each billing cycle, others give themselves 90 days.
Making sure you benefit from rate cut
Experts have several recommendations for credit cardholders looking to benefit from the Fed’s rate cut:
• Call your bank. If your credit card’s interest rate doesn’t fall within a month, call your issuer and ask for a cut. They may agree.
• Close the account. If that doesn’t work, you can opt to pay off your debt at the current rate and switch to a low interest rate card. You won’t be able to borrow any more on the old card.
• Remain disciplined. Focus on keeping your credit score up and consistently making at least the minimum credit card payments. Those steps add up to more than you would gain from Fed rate cuts.
Consumers should consult the disclosures provided by their credit card issuer to find out exactly how and when their own APR will change in the wake of the Fed’s decision.
Even if a card issuer has faithfully passed along every rate cut, the cumulative effect on a credit card bill may not be that much. Consider a cardholder with a credit card balance of $5,000 and an annual percentage rate of 15 percent. The minimum payment, calculated by adding the monthly interest charge plus 1 percent of the balance, would amount to $111.88 per month. If the interest rate were 12 percent — reflecting the 3 percent difference between today’s rates and when the Fed began cutting them last year — the minimum monthly payment would fall to $99.50.
The cumulative effect of these recent interest rate cuts, including the rate cut announced today, “has helped some borrowers somewhat. But the effect to borrowers struggling to get out of credit card debt has been negligible,” says Michael Rubin, author of “Beyond Paycheck to Paycheck.” Rubin explains, “The most important factor to eliminate credit card debt is something you — not the Federal Reserve — control. Rather than waiting for outside assistance, take ownership of your personal situation by paying the debt off.”
“Most Americans will receive $300, $600, $1,200 or even more when they receive their tax rebates in May. Put your cash toward your outstanding credit card balance and see some real interest savings right away. That found money is real cash and, used properly, can have a far greater impact to reducing your credit card debt than any Federal Reserve rate cut will have,” Rubin says.
See related: “Blog: My interest rate dropped, but not as much as Fed cuts”
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